Legacy Wealth Weekly - Sept 23, 2016 (A Divided Fed)

Penni Johnston-gill - Sep 23, 2016

US and Canadian equities advanced ~1.5% this week as the Fed and the BoJ dominated the financial landscape. The BoJ refined its strategy after years of monetary stimulus failed to jolt economic growth and inflation. In an attempt to mitigate the impa

Weekly Market Wrap-Up: A Divided Fed

US and Canadian equities advanced ~1.5% this week as the Fed and the BoJ dominated the financial landscape. The BoJ refined its strategy after years of monetary stimulus failed to jolt economic growth and inflation. In an attempt to mitigate the impact of NIRP on Japanese banks, the BoJ announced it would adopt a “QQE with Yield Curve Control”, tweaking bond purchases to keep 10-year bond yields at current levels of around 0%. Time will tell if this new framework will help stimulate the Japanese economy. Otherwise, the Fed decided to pass on a rate hike in September, as anticipated by market participants. The Fed's median policy rate projections for 2016, 2017, 2018, and GDP forecast were all reduced from projections offered in June. However, three FOMC members dissented from the decision and the “dot plot” still calls for a rate hike in 2016 if policy rate forecasts by FOMC participants are any guide. In all, it was a close call and a December hike seems a foregone conclusion.

Admittedly, weaker-than-expected data recently kept the Fed’s finger off the trigger. As shown in our Chart of the Week, US leading indicators (LEIs) have softened in August (-0.2% MoM) and over the past year. Consumer expectations, new orders and building permits all negatively contributed to US LEIs. As such, when financial variables are removed, the LEI is contracting YoY. In the past, similar conditions prompted the Fed to ease, not tighten. While the US economy is going through a lull and many economists have raised probabilities of a recession, investors should stay calm. As we showed recently, EMs are recovering and could well pull developed markets (DMs) going forward. As such, global economic synchronization could be a key theme in 2017, especially if DMs embark on fiscal reflation. Otherwise, following the BoJ and Fed announcements, stocks and bonds rallied, volatility collapsed and commodities advanced with the help of a weaker dollar. Going forward, gold prices (~2% WoW) and EM equities (~3%) should benefit from a "gradualistic" Fed. Investors should stop focusing on the second Fed hike as the third hike is usually the one that shocks risk assets. This third hike is very distant in the future and will require inflation at/above the Fed's target. Last, crude oil advanced ~3% WoW as the EIA reported a 6.2 MMbbl inventory draw. That said, we remain skeptical when it comes to yet another rumour of a production freeze agreement between Iran and Saudi Arabia. But with so much barking from the Saudis and Russia, they may have to walk the walk eventually.

Regarding economic statistics this week, in Canada, headline and core inflation settled at 1.1% and 1.8% YoY respectively in August (from 1.3% and 2.1%). Current weakness in inflation measures should keep the BoC on the sidelines, which potentially explains why the CDN$ is losing some ground today. Also, retail sales declined 0.1% MoM in July (2.3% YoY, from 2.7% in June) as lower prices at the pump hurt sales at gasoline stations (-3% MoM). In the US, building permits (-0.4% MoM), housing starts (-5.8%) and existing home sales (-0.9%) all disappointed, coming in at odds with the surge in the NAHB (65, from 59) in September. In Europe, the mfg. PMI improved to 52.6 (from 51.7) but that of services declined to 52.1 (from 52.8). Meanwhile, in Japan, the mfg. PMI advanced to 50.3 (from 49.5) while exports (-9.6% YoY from -14%) and imports (-17.3% from -24.7%) both improved. Finally, in China, home price inflation accelerated to 9.2% (from 7.9%), a good omen for Chinese commodity imports.

Next week, we will focus on US PCE inflation, durable goods orders and new home sales. Elsewhere, we await inflation in Europe as well as retail sales, industrial production and inflation in Japan.

The Canaccord Genuity research included in the Legacy Wealth Weekly is solely for Canadian residents. To subscribe to our weekly newsletter, click here.